Today's investment environment, roiled by stocks dropping more than 20% from their highs of last October through the first two weeks of July, is as challenging a one as we've faced. Even as we recognize that market declines are inevitable, often creating compelling opportunities for long-term investors, we share concerns over the market's recent plunge, how far prices may drop and how long the pain could last. It's extremely difficult to project the extent of the damage that the unwinding of the housing and credit bubbles will ultimately inflict on the economy and capital markets.

Unlike other periods of market excess, investors have been slow to get their arms around the extent of current problems. But while the unique aspects of this environment remind us that all declines come with their own set of causes and conditions, we also see an aspect typical of all downturns: the sense of fear that magnifies perceptions of risk and causes stock prices to discount more than fundamentals would dictate.

As emotions run high during challenging markets, historical data can be valuable for deriving rational perspective and insight. With that in mind, we decided to look at performance history to analyze how past market downturns have played out and, more specifically, the ultimate impacts of different levels of decline.

Study Parameters

Even after an extensive analysis of historical data, we did not expect to discover statistical rules of thumb or predictive factors that provide specific readings on this or future bear markets. We explored historical market downturns to look for patterns or trends that might help us understand why the market has a more extreme reaction in some situations than others and what we might expect during periods following sharp declines.

Enlisting the help of Ned Davis Research, we started by identifying any losses of 15% or more in the S&P Composite—and its successor, the S&P 500—since 1950. (We did not include this year's downturn because we are still in the midst of it.) Our starting point raises two questions: Why set the bar at 15%, and why confine scrutiny to the period since 1950 when data going back much further is available?

We chose the post-1950 period because we feel that data from the first half of the 20th century is less relevant to present market conditions, given changes in the economy and how it is managed. (For example, there are important market sectors, such as technology companies, that didn't exist prior to Word War II.)

As for why we initially chose to identify periods with losses of 15% or more, the simple answer is that this was the level of decline we had reached when we started the work a few months back. We also wanted to have a realistic framework for setting expectations.

While a 10% loss is certainly not fun, we did find numerous market corrections between 10% and 15% that quickly reversed themselves. Including these in our data set would risk minimizing the potential severity of market losses and the length of expected recovery times.

No Bounce-Back

That brings us to our first interesting discovery. Whereas market declines of 10% often reverse themselves, there have not been many periods during which the market decline reached 15% and didn't then go on to hit "official" bear market status—a decline of 20% or more. Eight of the 12 periods we examined experienced declines beyond 20%.

After we conducted this research, the most recent down market extended from 15% to beyond 20%. So our first observation is that while the slide into bear market territory in late June and early July generated many headlines and much hand-wringing, it is not surprising in the context of history.

In one instance when the markets did rebound, the S&P 500 dropped 17.1% in the winter of 1980 and then regained its high by the summer. Three other periods stopped just shy of the 20% mark. We included these three periods along with the 17% drop in 1980 in our analysis.

A Dozen Declines

As mentioned, our study identified 12 periods when the market declined 15% or more. It also showed that over the last 58 years, the S&P 500 has spent far more time going up than down. Whereas the market declined during about 12 of the last 58 years, it has generally risen over the other 46 years. So it's no surprise that bear markets over the past six decades generally have not lasted as long as bull markets.

The average downturn of about a year was less than a third of the average duration (three and one-half years) of the intermittent rising markets. Beneath the surface, though, the 12 periods we examined differed markedly in a number of ways.